As anticipated, the FOMC reduced its target range for the federal funds rate by 25 bps to 1.75%-2.00%. However, the decision was not unanimous as 3 out of 10 FOMC members dissented while latest dot plot projection suggested divided views ahead. Nevertheless, despite median projection suggesting no more rate cuts for 2019, there were 7 members who expect another 25 bps rate cut. Hence, we opine the FOMC remains on a fluid course and will continue to be data dependent. Should US-China trade tension continue with negative feedback on economic and financial data, it may lead the FOMC to cut another 25bps towards the end of the year. Closer to home, we maintain our expectation for BNM to reduce the OPR by 25bps within 6 months.

DATA HIGHLIGHTS

As anticipated, the FOMC reduced the target range for the federal funds rate by 25bps to 1.75-2.00%. The decision was supported by 7 members while 2 members voted to maintain the policy rate and 1 member preferred a larger reduction. Separately, the Committee has voted unanimously to lower the interest rate paid on required and excess reserves balances to 1.80% (previous: 2.10%) to foster trading in the federal funds market at rates well within the FOMC’s target range of 1.75-2.00%.

Overall, the FOMC was neutral on the economy. While it maintained its assessment on job market and consumption, it was less sanguine on investment and exports. The Committee said job gains have been strong, and the unemployment rate remained low. Although household spending has been rising at a strong pace, business fixed investment and exports have weakened. On inflation, the Committee noted that overall inflation and inflation for items other than food and energy are running below 2%. Market-based measures of inflation expectations have remained low while survey-based measures are little changed. While the Committee continues to view sustained expansion of economic activity, strong labour market and inflation near the 2% objective as the most likely outcomes, uncertainties about this outlook remained.

2019 GDP was increased to 2.2% (previous: 2.1%) and anticipated to ease to 2.0% (previous: 2.0%) in 2020. The longer-run GDP remained at +1.9%. Unemployment forecast in 2019 was nudged up to 3.7% (previous: 3.6%) and expected to remain at 3.7% (previous: 3.7%) in 2020. Forecast for 2019 and 2020 PCE deflator was constant at 1.5% YoY and 1.9% YoY respectively. Similarly, core PCE deflator forecast was also maintained at 1.8% YoY and 1.9% YoY for 2019 and 2020 respectively. For 2019 and 2020, FOMC members’ projection of median fed fund rate was lowered to 1.9% (previous: 2.4% and 2.1% in 2019 and 2020 respectively). For 2019 projection, members are divided on policy interest rate direction (another 25 bps rate cut: 7 members; no change: 5 members; 25 bp rate hike: 5 members).

HLIB’s VIEW

Despite the 25bps reduction in federal fund rate, the risk of no further rate cuts led to disappointment in the financial markets. The 25bps cut was the second interest rate reduction since July 2019. However, the decision was not unanimous as there were three dissenters (Esther L. George, Eric S. Rosengren and James Bullard). While median projection showed no more rate cuts for 2019, there were 7 members who expect another 25 bps rate cut. Hence, we opine the FOMC remains on a fluid course and will continue to be data dependent. Should US-China trade tension continue with negative impact on economy and financial market, it may lead the FOMC to cut another 25bps towards the end of the year. Closer to home, we maintain our expectation for BNM to reduce the OPR by 25bps within 6 months.

Source: Hong Leong Investment Bank Research - 19 Sept 2019